Financial Intermediation Chains in an Over-the-Counter Market

Abstract

We analyze financial intermediation chains in a search economy that is populated by investors with heterogeneous valuations of an asset. In equilibrium, investors with moderate valuations choose to be intermediaries, and those with extreme valuations are their customers. The average length of intermediation chains is shown to be decreasing in search cost, search speed, and market size but increasing in investors’ trading needs. These predictions are distinct from those implied by existing models in the literature. Our empirical evidence, based on data from the U.S. corporate bond market, is mostly consistent with our model predictions. This paper was accepted by Tomasz Piskorski, finance.